Thursday, April 23, 2009

The following is a recommended reading text that compares two countries and economies with a similar evolution, it also shows how in Spain can happen the same things that are happening right now in Ireland.

Spain could be sliding towards harsh budget cuts like those forced on another former euro zone high-flyer, Ireland.

Concern about Ireland's deficit and exposure to bank losses pressured its government to slash spending and hike taxes this month to reassure investors of its long-term solvency.

Although Spain has just launched a bank restructuring plan, it has nothing like Ireland's exposure to bank liabilities nor its dependence on housing-related revenues. This relatively favorable position means bond markets are giving Spain more freedom to spend, but therein could lie its greatest risk.

Spain's Socialist government may be given enough fiscal room to double its debt level and build a double-digit deficit, then be unable to correct imbalances as growth fails to rebound.

In such a scenario, rating agencies could turn on Spain and impose the same kind of downgrades that have hit Dublin, which launched what critics dubbed "the budget from hell".

"You can think of Spain as a slow-burn situation. If they don't get the right policies over a number of years, they'll get themselves into quite a mess over public finances," said BNP economist Dominic Bryant.

Spain is the only one of the world's eight largest economies that will suffer two consecutive years of contraction in 2009 and 2010 after the collapse of its domestic housing boom coincided with the global crisis, according to Fitch Ratings.

Unemployment in Spain is rising faster than in any other developed country and is widely expected to top 20 percent, or 4.5 million, in 2010.

On the eve of the global crisis, Spain and Ireland seemed in good fiscal shape with balanced budgets and low public debt after running the euro zone's two biggest ever property booms.

In the space of 18 months, the Spanish and Irish governments have had to take responsibility for the collapse of housing and credit bubbles funded by their private banks.

Spain launched one of Europe's biggest fiscal stimulus packages, paid for by public borrowing, and Ireland could see a massive jump in national debt due to its efforts to cleanse banks of tens of billions of Euros in risky assets. Most analysts say Ireland's government has been forced to punish its economy to save banks, a situation Spain must avoid.

"I am angry and disillusioned at the price we all have to pay for the failures to manage the economy," wrote Jim Power of financial services firm Friends First after Ireland's emergency budget was unveiled.

Spanish Prime Minister Jose Luis Rodriguez Zapatero has made no secret of his aim to keep up discretionary spending and compensate for a collapse in construction, tourism, and car sectors that formerly drove half of Spanish growth.

He fired Economy Minister Pedro Solbes this month after he said Spain had to respect EU deficit limits and appointed his public administration chief to speed up fiscal stimulus equivalent to nearly 5 percent of gross domestic product.

Spain's government accuses Bank of Spain Governor Miguel Angel Ordonez of alarmism for warning the social security system could enter deficit and Spain must launch structural reforms, the need for which the IMF also emphasized on Wednesday.

In the case of Ireland, pressure from the European Commission and markets helped convince Dublin to place a levy on public servants' pensions to improve social security accounts.

"If you look at a country like Spain it just shows how politically difficult it is to push through these kinds of decisions," said Rossa White at Dublin-based brokerage Davy.

Interesting Vocabulary:

Harsh - severeSlash - To reduce or curtail drasticallyRebound - To recover, as from depression or DisappointmentEve - The period immediately preceding a certain eventCleanse - To free from dirt, defilement, or guilt; purge or cleanUnveil - To disclose; revealLevy - the imposition and collection of taxes, tariffs, or fines.